Transition to GST: Tough negotiations lie ahead

Finance ministers from India’s states met in Delhi on Wednesday to discuss a transition to a Goods and Services Tax (GST) regime. The meeting couldn’t resolve issues raised by states. Reconciling the varied needs of states and instilling confidence in them is going to be quite a challenge. Tough negotiations lie ahead.

Two states, Tamil Nadu and Gujarat, communicated their problems ahead of Wednesday’s meeting. Tamil Nadu chief minister, J.Jayalalithaa, wrote a letter to Prime Minister Narendra Modi on her state’s issues with a draft GST legislation that has been circulated.

States such as Gujarat and Tamil Nadu have a set of apprehensions that are unlike many other states. These are more industrialized states, where state governments raise most of their aggregate revenue receipts through their own taxes. In the case of Gujarat, Maharashtra and Tamil Nadu usually around 77% to 80% of revenue receipts come through their own taxes. Therefore, any change in the tax base causes apprehension.

In contrast, states such as Bihar and Jammu and Kashmir raise about 27% to 28% of their total revenue receipts through their own taxes. The rest of the revenue comes through transfers from the central government.

Two issues seem most bothersome to industrialized states. Today, goods manufactured in their states is ‘exported’ to other states and sold all over. The industrialized states collect a tax, central sales tax (CST), on this export.

GST envisages a shift to taxing consumption. Therefore, unlike the current situation, if a car manufactured in Chennai is sold in Delhi, the entire tax accrues to Delhi government.

This is one aspect that bothers industrialized states and hence the constant demand for a permanent compensation mechanism. Their justification is twofold. The industrialized created infrastructure to attract industries and CST goes some way in compensating the states for their investment. In addition, the risks of pollution and related problems are borne by states where industries are located. This, in turn, can raise healthcare spending for states where industries are located. However, once the transition to GST takes place, a key source of revenue is taken away.

It is the anxiety to protect their revenue base that makes some states reluctant to sign up for the current draft GST bill. Their objections are usually expressed in the form of reluctance to allow too many high tax items such as petroleum products to be subsumed into GST. Also, there is a constant emphasis on compensation mechanisms for a likely loss in revenue.

The bottom line is that high revenue earning states with large manufacturing bases remain apprehensive of a radical change in a tax system where consumption will be point of levying indirect taxes. Most states acknowledge the overall benefits of GST, but the impact transition will have on their own balance sheet has triggered the anxiety.